Fixed costs are business expenses that do not change as the level of production goes up or down. They are one of two types of business expense, the other being variable costs. Variable costs do change as the volume of production changes.
For example, a lease on a building is a fixed cost, because the monthly rent is the same regardless of production. Raw material costs, on the other hand, are variable costs, because increasing or decreasing production requires an immediate change in raw materials.
Fixed costs are the key to achieving economies of scale, meaning a company makes more profit per unit as it produces more units.
For example, Marcel’s Monster Bikes has a lease for $50,000 per month. If it produces 5,000 bicycles, the cost of the lease is spread over 5,000 units, or $10 per bicycle.
If the company sells 10,000 bicycles, it spreads the fixed cost of the lease over more bicycles. The cost of the lease is now $5 per bicycle.
Marcel’s Monster Bikes now has lower cost—and higher profit—per bicycle by producing more units while keeping some costs fixed. This is economies of scale.
Note that fixed costs are only fixed over a certain range of production volume. When production increases far enough, fixed costs generally must be increased.
For example, if Marcel’s Monster Bikes sells 100,000 bicycles, it will likely have to lease another building and hire more managers, raising its fixed costs.
Source: http://www.investopedia.com
